Have you ever wondered how to pay yourself? Can you confidently say that you are paying yourself correctly? When you’re rocking your creative business and you’re finally making money, you will still have personal bills to pay. How to pay yourself is a common question that I have come up from my bookkeeping clients and from members of my creative community. I want to help you understand it all, so I’m going to walk you through two different ways to pay yourself from your creative business.
Business Structure and How to Pay Yourself
The first thing you need to know is the way that you pay yourself depends on how your business is structured. There are two ways that you can do this. The first way is if you are a Sole Proprietor, DBA, Single Member LLC, Multi Member LLC, or Partnership. The second way will be if you’re an LLC electing to be taxed as an S Corporation.
How to Pay Yourself as a Creative Entrepreneur
If you’re a Sole Proprietor, DBA, Single Member LLC, Multi Member LLC, or Partnership, the profit of your business is considered your taxable income. When you look at your profit and loss statement and you see your income minus your expenses, that amount is what actually transfers over to your personal tax return and that’s where your taxes are calculated. It’s known as a flow through entity, meaning the taxes owed flow through from the business into your personal tax return. I have a training covering the 5 Taxes You Should Know as a Creative Entrepreneur here.
What is an Owner Draw?
If you’re set up in one of these ways, the Sole Proprietor, DBA, Single Member LLC, Multi Member LLC, or Partnership, you can transfer money from your business account to your personal account to pay yourself. This is known as an Owner Draw. You are drawing funds from your business to pay for your personal expenses. This is important: Owner Draws are not expenses to your business. They do not lower your net income, they actually appear on the balance sheet as a change, actually a decrease in owner equity, because you’re taking equity out of your business. I just want to clarify it because sometimes people think a draw is an expense to the business and it’s not.
Calculating Taxes When You Pay Yourself
Here is an example of this. Let’s say that your net income, so your income minus expenses on your profit and loss, is $5,000. But you’ve only taken $100 in draws. The $5,000 is what transfers to your personal tax return, and that is still what you’re going to pay taxes on. “What taxes?” you might be asking. You’ll pay Federal Income Tax to the IRS, State Income Tax to the State if you live in a state that has income tax. Not every state does. And you’ll pay a fun little tax called Self Employment Tax.
Important Taxes to Know About as a Creative Entrepreneur
Federal Income Tax can range from 10 to 24%, and it’s based on your taxable income on your personal return once you bring everything together (your spouse’s income, your business income, maybe other jobs you have). Once that’s all calculated, that’s how that percentage is found. State Tax can differ too. The best practice is to look at last year’s tax return and see what tax bracket you were in for your state. Self Employment Tax is 15.3%. You can take the 15.3% plus the percent for your state and the percent for federal, and use that as the amount that you want to set aside from your business income so that you can pay taxes.
Estimated Taxes for Creative Entrepreneurs
It’s also important to understand that you need to be making estimated tax payments.You can learn all about Estimated Tax Payments here. I would say a good range is 30, 35% to 45% set aside to cover all the taxes that you’ll need, if you’re set up in the way listed above, because the second way is a lot different. The second way to pay yourself is for anyone who is an LLC that is elected to pay taxes as an S Corporation. If you are set up as an S Corporation, you are required to take a reasonable salary through a payroll service. You need to have payroll set up for your business within your business to pay yourself. When you pay yourself, it’s going to be just like you were at another job. You’ll get a W2, you’ll get a paycheck of your net pay. The business will process payroll, and will pay all the taxes and withholdings that need to happen.
Are you an S Corporation?
It’s important to know if you are electing to pay taxes as an S corporation, it is not a choice. It is a requirement to be compliant with the IRS to be taking a proper payroll through a payroll service. I find this is something a lot of Creative Entrepreneurs, don’t understand completely, and haven’t been taking payroll. You need to know on your 1120-S, which is the tax return for an S Corporation, which is separate than your personal, there’s actually a line that says shareholder salary. If that line is empty, that’s tells the IRS that you do not take salary and you are not compliant. So you want to make sure you understand how this works and follow all the rules.
How is Paying Yourself as an S Corp different?
The first method on how to pay yourself was for Sole Proprietors, DBA, Single Member LLCs, Multi Member LLCs and Partnerships. The second method on how to pay yourself is for anyone electing as an S Corp, and you can only elect as S Corp if you’re an LLC. These are two very different ways to pay yourself. The tax savings you get as an S Corporation is if you are on payroll because you are already paying in to some of your taxes. Those who are in S corporations do not pay that self employment tax that we covered in the first method. It’s super important if you’re set up as an S Corporation or thinking about being set up as an S Corporation, that you have a full understanding of what the requirements are. To learn more about S Corporation, check out my Business Structure Bootcamp.
Benefits of Paying Yourself as an S Corp
Two benefits to being set up as an S Corp is that you no longer pay that 15.3% Self Employment Tax, and the best part is whatever you pay yourself through payroll and the taxes that are calculated on top of that are an expense to your business. You are now lowering that net income number that will eventually flow through to your personal tax return. You’ll still pay the Federal Income Tax and State Income Tax, but not Self Employment Tax. You are only paying the Federal Income Tax and the State Income Tax on that way lower net income number after the pay that you’ve taken for yourself. Your pay can only be considered an if you are set up this way.
How your business is structured will determine which method you will use to pay yourself. For more information and a deeper dive into how to structure your business, check out my Business Structure Bootcamp.
I hope that this helped you find the best way to pay yourself as a Creative Entrepreneur. You can grab more support and resources for your creative business in my community, #CreateMore with Tiffany. Every Friday, you can grab my LIVE Coaching Call on topic just like this! If you are ready to get your financial sh!t together and makeover your creative business bookkeeping, join Master Your Bookkeeping. Doors close August 31st, 2020!